His $3.6 billion Total Return exchange-traded fund has more
than quadrupled its allocation to such notes since January to
more than 41 percent of its holdings. Gross isn’t the only one
to find high-grade corporate bonds more appealing lately, given
mutual-fund investors have poured $63 billion into the debt this
year after pulling record amounts in 2013, according to Wells
Fargo & Co. data.

On one hand, this makes sense because the U.S. economy has
been picking up and the most-creditworthy companies look pretty
good based on their balance sheets.

On the other, this more than $5 trillion slice of the U.S.
bond market is about as sensitive as it’s ever been to moves in
benchmark interest rates and the Federal Reserve’s preparing to
raise borrowing costs next year.

The extra yield, or spread, investors demand to own
investment-grade company debt instead of Treasuries is near the
lowest since before the 2008 credit crisis. This means any
ripple effects from the Fed’s exit will be all the more painful
for holders of this debt.

“You have to be cautious and careful about this because we
do think higher rates are coming,” said George Rusnak, national
director of fixed income for Wells Fargo Private Bank. “As
spreads are less, you’re less protected.”

Outperforming Junk

At the same time, benchmark bond yields aren’t likely to
rise much during the next six months, so investment-grade
corporate securities should hold their value, he said. When
rates do rise, the notes may outperform junk bonds -- which have
benefited disproportionately from a search for yield amid
unprecedented Fed stimulus.

Pimco’s Total Return ETF, which follows a similar
investment strategy as the firm’s $223.1 billion Total Return
Fund, has been steadily increasing its corporate-debt holdings
throughout the year. The notes account for more than 41 percent
of the fund now compared with as low as 9.73 percent at the end
of January, according to data compiled by Bloomberg.

The two-year-old ETF shrunk its allocation of government-related debt, reducing the proportion of such notes to 27
percent from 40.23 percent at the end of last year.

Mark Porterfield, a Pimco spokesman, declined to comment.

The bets have paid off. U.S. high-grade notes are poised
for an annual return of 10.4 percent, the most since 2009 when
credit markets were rebounding from their seizure, according to
Bank of America Merrill Lynch index data. Junk bonds, meanwhile,
are on track for an 8.9 percent gain.

Investors are demanding 1.13 percentage points of extra
yield over Treasuries to own investment-grade debt, down from
6.56 percentage points in December 2008. In June, the spread
fell to 1.06 percentage points, the lowest since 2007.

In other words, investors are demanding less and less
compensation for owning debt that’s safe enough.